One of the scariest things about running a small business is that you’re always one or two dominos away from disaster. All it takes is a supplier to shut down or a major client to switch to the competition and you’re in big trouble. Thankfully, an emergency fund can keep you safe.
What is an Emergency Fund?
Everyone has their own definition of exactly what an emergency fund consists of, but the purpose remains the same. It’s a fund of cash reserves that you set aside in order to cover unforeseen critical expenses that arise during the normal course of doing business.
In personal finance, the general rule of thumb is to keep between three and six months of household expenses in an emergency fund. This same principle is valid in business. So, for a business with $10,000 in monthly expenditures, this means the emergency fund should be somewhere in the $30,000 to $60,000 range.
In addition to the amount, you also need to think about where the money is going. You want your emergency fund to be liquid, but not so accessible that you’re tempted to dip into it in a non-emergency scenario. The best advice is to keep it in a normal savings account that’s separate from your spending account. (The goal isn’t to get a big return on your money. It’s a cushion, not an investment.)
4 Tips for Building an Emergency Fund
Now that you’re familiar with exactly what an emergency fund is, let’s take a look at some practical tips for putting this knowledge into action.
- Develop a Budget
If you don’t already have a formal budget for your small business, now’s the time to develop one. You need to know exactly how much money is coming in and going out – down to the dollar. There’s no excuse for having anything but total clarity in this area.
- Eliminate Unnecessary Expenses
An emergency fund isn’t going to arise out of thin air. It’s most likely going to take you several months to build. Now that you have a budget, you can see where your money is currently being spent and set savings goals.
In order to achieve your savings goal, you’ll have to eliminate sources of pointless spending. The more aggressive you are with stripping down your budget to the basics, the faster you’ll get there.
- Establish Rules
Building an emergency fund is only half the battle. Once you have three to six months of expenses sitting in an account, you’re going to find it hard not to touch it. There will be moments where it seems really easy to reach in and grab it, but resist.
“One way to avoid this is to define situations that you and your team consider to be critical business emergencies. Commit to using the fund only when these circumstances arise,” Summit Financial Resources advises.
Every business will have its own definition of an emergency, but these are typically expenses that must be covered immediately in order to keep the business operating at a profit.
- Refill After Spending
There are times when you will need to use your emergency fund. Just make sure you fill it back up after using it.
For example, let’s say you take $5,000 out of your emergency fund to pay for the repairs on a piece of equipment. Make it a point to refill this $5,000 over the next one to three months by making it a “payment” item in your budget.
Always Have a Safety Net
If major corporations like Blockbuster, Kodak, Circuit City, Pan Am, and Toys ‘R’ Us, can all go from being industry leaders to bankrupt, so can your small business.
It doesn’t matter how good things are going at the moment, you always need a safety net, because you will fall from time to time. An emergency fund won’t keep you afloat for years, but it can help you weather temporary storms and stay operational in the midst of isolated challenges and momentary disruptions.
Don’t wait any longer. Now’s the time to establish that safety net. And even if you never have to access it, the peace of mind it affords you is invaluable.